Second Quarter Conference Call, Fiscal Year 2019



Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties and other factors is contained in our news release of April 26, 2019 our most recent Form 8K filed on April 26, 2019 and in certain of our other public filings with the SEC.


We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our investor relations home page and webcast page at

Good morning.  Thanks for joining us.  This morning we’ll report on the second quarter of fiscal ‘19 and update our guidance for the full year. Overall, our underlying operations performed well this quarter and the year is shaping up nicely. Unfortunately, we had a supplier quality issue in the quarter which negatively impacted our results. 

Let me start with the headlines.



1.    First, it was another good quarter for our operations.  Sales were up 4% and, adjusted earnings per share of $1.40 were up 21% from last year, above the high end of our guidance from 90 days ago.  We took a $10 million charge for a supplier quality issue in the quarter which resulted in a 20c hit to earnings per share, yielding GAAP EPS of $1.20. 

2.    Second, free cash flow conversion was low in the quarter due to a buildup of working capital and accelerated CapEx spend. 

3.    Third, the grounding of the 737 MAX has not had any direct impact on our company to date.  Based on Boeing’s outlook for production and return to service, we’re not adjusting our forecast for the year at this stage. Our shipset value on a 737 MAX is about $50 thousand dollars.  

4.    Finally, the macro economic conditions remain positive across defense and commercial and are stable in industrial. This supports our continued confidence in our revenue outlook for the full year. 


Now let me move to the details starting with the second quarter results. 


Q2 Fiscal ‘19

Sales in the quarter of $719 million were 4% higher than last year. Underlying organic growth was 5%, offset by 1% in forex movement. Sales were way up in Space & Defense, modestly stronger in Aircraft and about flat in Industrial Systems.  This quarter, our P&L was affected by the supplier quality issue, while last year’s numbers were affected by the decision to exit the wind pitch controls business.  Adjusting for both these effects, our underlying gross margin from operations this quarter was more or less in line with last year at 29%.  Both R&D and SG&A were down as a % of sales relative to a year ago.  Our effective tax rate was 23.8% to yield GAAP net income of $42 million and earnings per share of $1.20. 

Fiscal ’19 Outlook

At the half way mark of our fiscal year, we’re comfortable keeping our sales guidance of $2.9 billion unchanged from last quarter. Absent the charge in Aircraft this quarter, we’re also on track to meet our original EPS guidance of $5.25/share.  Including this charge, our new EPS forecast for the full year is $5.05/share, plus or minus 20c. 

Now to the segments. I’d remind our listeners that we’ve provided a 3-page supplemental data package, posted on our website, which provides all the detailed numbers for your models.  We suggest you follow this in parallel with the text.




Aircraft Q2

Sales in the quarter of $321 million were 3% higher than last year. Commercial OEM sales were up a healthy 11%, with growth on the 787, A350 as well as several business jet programs. The commercial aftermarket was down from last year. The aftermarket story is almost the inverse of the OEM growth, with lower activity on the 787 and in our business jet product line. The A350 aftermarket was up slightly from a year ago. 

On the military side, sales were about flat with last year. Slightly higher F-35 sales were more than offset by lower sales in our helicopter product line. Last year Q2, we had an unusually strong quarter for Black Hawk sales and this year they returned to a more normal run rate. In the military aftermarket, we had higher activity on both the F-35 and V-22 platforms. 

Aircraft fiscal 19

We’re keeping our full year sales forecast unchanged from 90 days ago, at $1.3 billion, up 6% from fiscal ’18.  We’re adjusting the mix slightly, reducing A350 sales by $8 million and increasing sales to Gulfstream by the same amount. At the halfway mark, sales are tracking nicely to plan. For the second half, we expect a slight acceleration in the A350 sales but a slightly lower commercial aftermarket. On the military side, we should see marginally higher OEM sales and aftermarket sales pretty much in line with the first half.

Aircraft Margins

Margins in the quarter of 8.5% were adversely impacted by 300 basis points due to the supplier quality issue I mentioned in the headlines.  This issue was caused by one of our suppliers changing one of their sub-suppliers. This new sub-supplier introduced a defect in their process, which got through our supplier’s manufacturing and in turn was passed on to us.  We discovered this issue in our operations and, over the last few months, have worked to rectify the problem going forward.  The charge we took this quarter is associated with the costs to correct this issue.

Absent this charge, underlying margins from our operations are up 60 basis points from both the first quarter and from the same quarter last year. Lower investment in R&D drove the improvement year over year.  We expect an acceleration in R&D spend as we move into the second half of the year, which will result in full year R&D at just over 5% of sales. 

Excluding the $10 million charge, we’re keeping our margin forecast for the year unchanged.  Including this charge, the revised margin for the year will be 10.6%.



Space and Defense

Space and Defense Q2


Sales in the quarter of $165 million were 15% higher than last year.  Similar to the first quarter, the growth is all coming from the defense side. Sales into defense were up across all our major business lines. We saw growth in volumes on our Hellfire and TOW missile products as well as increased sales for funded missile development work. Sales on our new turret system were also up nicely from a year ago.  In general, we’re benefitting from the increased tempo of defense spending across the complete range of applications we serve. 

Sales into the space market were down from a strong Q2 a year ago. The drop was primarily in our satellite components and avionics product lines, with sales into NASA applications flat year over year.  


Space & Defense fiscal 19

We’re leaving our full year forecast unchanged from 90 days ago at $681 million. We’re adjusting the mix slightly within the defense portfolio. The ramp up of new programs for our new turret system are moving a little slower than anticipated so we’re moderating that forecast for the year down to $40 million. However, we’re forecasting increased sales of defense components and security products that will make up this short fall.  Net, net, no change. Our full year sales forecast assumes an acceleration in the second half for both our space and defense product lines. We’re comfortable with this outlook as the macro picture for both Space and Defense remains very bullish. 

Space and Defense Margins

Margins in the quarter of 12.4% were up 50 basis points from last year.  For the full year, we’re keeping our margin forecast unchanged at 11.8%. 



Industrial Systems


Industrial Systems Q2


Sales in the quarter of $233 million were in line with last year.  Real sales were up about 3% in local currencies, but the strengthening dollar offset this gain. Sales into the Energy market were down as a result of last year’s exit from the wind pitch controls business, while sales into energy exploration applications continue to grow as the price of oil remains strong. Sales into industrial automation were higher on the acquired sales of our large motor facility in the Czech Republic.  Sales into the simulation and test end market were about flat with last year while sales into medical devices applications were up on stronger enteral pump sales. 

Industrial Systems fiscal 19

We’re keeping our sales outlook for the year unchanged at $931 million. Sales into the industrial automation market will be about flat in the second half, with a slight acceleration in sales in our other 3 submarkets. Our book to bill in the second quarter remained slightly above 1, supporting this positive outlook.  

Industrial Systems Margins

Margins in the quarter were strong at 13.0%. We enjoyed a particularly favorable mix this quarter and our expenses were slightly below plan. For the full year, we’re keeping our margin forecast unchanged at 12%. 




Summary Guidance


Q2 was another good quarter for our operations with adjusted earnings per share at the high end of our guidance range. Through the first half, sales are up 6% and adjusted earnings per share of $2.65 are up 23% from last year.  Our Aircraft Group is on track for 6% sales growth this year, driven by strong growth across the military portfolio and the continued ramp up of production on our key commercial platforms.  In our Space and Defense Group, we’re anticipating modest growth in our space applications, and very strong growth in our defense business – spread across our complete range of applications. The overall macro picture for defense spending remains very positive, while the space community is anticipating strong growth in future years on the back of the GBSD program, hypersonic missile developments and NASA’s plan to return to the moon in 2024.  As I said last quarter, we’re feeling comfortable with our fiscal ’19 outlook for industrial systems, but the low growth in Europe and the risks of a slowdown in the U.S. over the next 12 months are reasons for caution as we look out beyond this year. We’ll be keeping a close eye on these macro-economic trends and adjusting our business accordingly. 

As always, there are upside opportunities and downside risks associated with our forecast. I believe there continue to be opportunities for upside in our defense businesses, although the war for talent remains a real challenge to realizing these opportunities. Similar to last quarter, I think the longer-term downside risk is in our industrial business. We try to provide the market with a forecast which balances these pluses and minuses. 

Last quarter I finished by saying that the optimist in me would hope that, when we report our second quarter results, the government shutdown would be long over, there would be a sensible Brexit strategy and the trade dispute with China would have been resolved. Well, we’re one for three.  Let’s hope that when we report on our third quarter, we’ll have a better score.      

Overall, fiscal ’19 is shaping up nicely. Our sales forecast of $2.9 billion is unchanged from 90 days ago and our underlying operating margin is on track, absent the supplier issue.  For both the third and fourth quarter we expect earnings per share of $1.30, plus or minus 10c.  

Now let me pass you to Don who will provide more details on our cash flow and balance sheet. 


Thanks, John.  Good morning.

Free Cash Flow for Q2 was $9 million bringing our six-month total to $49 million.  This represents a YTD conversion of less than 60% reflecting growth in receivables, inventories and capital expenditures.  Receivables and inventories have increased due to our topline growth and due to the timing of shipments to our customers.  Capital expenditure activity has been significant largely related to a building addition for our Aircraft operations (which is needed to accommodate the growth in our military aircraft business) and growth-related investments in machinery and test equipment.  Demographic trends and hiring challenges have resulted in us making a bigger investment in automation sooner than we had been projecting.

Looking ahead to all of 2019, we’re moderating our forecasted Free Cash Flow to $160 million, down from our previous forecast of $185 million. The previously described $10 million reduction in our projected operating profit in combination with a $15 million increase in our forecasted capital expenditures accounts for the $25 million FCF reduction for all of 2019. This update reflects a revised cash flow conversion of 90%.  In recent years, we’ve enjoyed average FCF conversion well in excess of 100%. This year, increases in working capital and CapEx to support our topline growth are offsetting the benefit of not making any contributions to our U.S. Defined Benefit Pension Plan.  We remain focused on generating a respectable long-term FCF conversion that will average at least 100%.

Net Working Capital (ex cash and debt) was 26.8% of sales at the end of Q2 compared with last year’s 25.5%. The adoption of the new accounting standard for revenue recognition in 2019 inflated this ratio in Q2 of 2019 by about 70 bps. After making that adjustment, the residual 60 bps increase reflects the growth in the Balance Sheet elements that I’ve just described. We’re expecting this ratio to decline to between 25% and 26% by the end of the fiscal year.

Net debt increased $7 million compared to Free Cash Flow of $9 million. The difference relates primarily to the payment of our quarterly dividend.

Capital expenditures in the quarter were $36 million while depreciation and amortization was $22 million. YTD, CapEx was $60 million while D&A was $43 million. For all of 2019, we’re increasing our CapEx forecast from three months ago to $110 million for the reasons that I described earlier. D&A in 2019 will be about $87 million.


Cash contributions to our global pension plans totaled $10 million in the quarter compared to last year’s second quarter of $80 million. Last year included incremental accelerated contributions to our U.S. DB pension plan to take advantage of some tax benefits related to the Tax Act passed by Congress in December 2017. For all of 2019, we’re planning to make contributions into our global retirement plans totaling $36 million, nearly unchanged from our forecast three months ago.  Global retirement plan expense in Q2 was $16 million compared with $15 million in 2018.  Our expense for retirement plans for all of 2019 is projected to be $63 million, an increase over last year’s $57 million and essentially unchanged from our forecast three months ago.

Our Q2 effective tax rate of 23.8% compares with our forecast for all of 2019 of 26.0%.  The lower rate this quarter is due to a residual impact related to last year’s decision to exit from the wind pitch controls business. YTD, our tax rate is 24.1% compared with last year’s 79.2% which was complicated by the significant effect of the Tax Cuts and Jobs Act enacted last year and the Wind business restructuring.  We’re still projecting our tax rate for all of 2019 to be 26.0%.

Our leverage ratio (Net Debt divided by EBITDA) was 2.1x at the end of Q2, unchanged from last quarter and from a year ago. The Free Cash Flow that we’ve generated over the last twelve months has been consumed by acquisitions and share buybacks.  Net debt as a percentage of total capitalization at the end of Q2 was 35% compared with 34% a year ago. At quarter-end, we had $520 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.  And our $300 million of 5.25% high-yield debt matures in 2022.

Interest expense in Q2 was $10 million compared with last year’s $9 million, up due to higher borrowing rates.  Our forecasted interest expense for all of 2019 is $38 million, essentially unchanged from our forecast last quarter.

With respect to leverage, we’ve previously shared that our target leverage is between 2.0x and 2.5x (Net debt divided by EBITDA).  We’re within our target range at 2.1x at the end of Q2.  And with respectable free cash flow forecasted for the balance of 2019, we expect to be below our target range by the end of the year, everything else unchanged. We just announced today our fifth consecutive quarterly cash dividend for our shareholders. We continue to look at M&A targets strategically and share buybacks opportunistically. 

We’re off to a pretty solid first half of 2019 with sales up 6% and adjusted EPS up 23%.  And our backlog has increased over 20% in the last twelve months. In summary, our businesses are growing, we’re seeing improvement in margins and our longer-term free cash flow outlook remains encouraging.

With that, I’d like to turn you back to John and open it up for any questions you may have.